BoJ’s chief looking to be moving the policy goal post

BOJ cheif, Ueda-san’s latest admission that the central bank’s outlook for falling inflation rate could be wrong was significant. His comments may imply that the bank could be considering dropping its insistence that Japan’s inflation is ‘transitory’ or ‘cost push’ driven as BOJ has termed. This comes almost 18 months after other monetary authorities had come to same conclusion and began their monetary tightening process.

More economists are now also calling for a revision in BOJ’s H2 inflation outlook which calls for tamer prices in the second half to below 2%. Indeed, the bank needs to regain some credibility in its forecasts which have been way off the mark for many quarters now. We have long underlined that Japan could have a big inflation problem that goes beyond the cost-push narrative of Kuroda, which until now, his successor had stuck with.

We have also deemed BOJ’s continued super-easy monetary stance as a big error that could lead us back to dangers of a very weak yen scenario, and in turn raise upward pressures again on import bills. This is creating yet another negative feedback loop that forced MOF to intervene in the currency market last October when dollar/yen rate was approaching Y150 level. 

This briefly scared away the speculators and coupled with BOJ’s surprise tweak in December that seemed more a stealth tightening, the yen had regained its footing and had overshot back towards 127 level. With dollar/yen at 140 now, it does look once again that carry trade bets against the yen have been the dominant factor in the currency’s recent moves as Ueda had continued to push the line of staying the course.  

Although the recent base effect has helped food, oil and gas prices to temporarily dampen the upturn in the headline inflation rate, we suspect Japan’s underlying gauge will remain well above BOJ’s 2% target. The latest data from May’s Tokyo CPI rate had surprisingly eased to 3.2%. However, core inflation which excludes these volatile elements are still heading higher as they are elsewhere, in other developed economies. 

Even service price inflation which had been fairly tame is starting to approach that 2% target as booming inbound tourism in Japan is raising hotel rates and other service fees. Moreover, with regional electric power firms having been given the nod to raise their prices by double digit levels, BOJ’s own think tank reckons that the impact of this could be half a percent rise in Japan’s inflation rate in the second half of the fiscal term. 

It is also worth noting that over Y2trn of government’s household subsidies which have been keeping the headline rates down since January (when the rate peaked at 4.3%) are about to expire in September. The government will most likely extend these to keep the national household costs down while fiscal budget deficit remains on a steep uptrend that only increases the supply of new bonds. 

But, the new governor also looks to be moving BOJ’s previously stated goal post by declaring that wage growth is no longer a precondition to raise rates, just when wage growth looks to be building strong momentum. This is especially so with mid-career movements in Japan which are on a steep rise, having reportedly led to very high salary upgrades by those who have changed firms. 

With Japan’s structural labour shortages almost guaranteeing strong wage growth to continue, Ueda’s latest statement seems targeted to get BOJ off the hook in being rushed into normalising its monetary policy.  Indeed, we are starting to think BOJ’s decision to maintain its ultra easy policy could be politically motivated to keep government’s financing costs from surging higher.

This could explain why BOJ is desperate to remove the preconditions of the past to stick with its policy errors, cheered on by the government which is on a big spending spree to keep the LDP party in power and Japan’s allies happy. If BOJ’s monetary policy is indeed rigged by the government, despite bank’s stated independence, then we might have a bigger problem that we initially thought was just Kuroda’s stubbornness to protect his legacy. 

As we noted when Kishida-san’s household subsidies were first announced, the government seems to have created yet another big recurring expense bill that it is unlikely to be able to walk away from anytime soon. With big cash handouts to support child bearing on the offing, reportedly worth Y8trn, coming on top of surging defence spending targeting 2% of GDP by 2027 (and up by 24% to Y6.8tn this year) there is much pressure on the budget deficit which is fast approaching 300% of GDP and with BOJ owning close to 60% of outstanding JGB bonds.

With Japanese government having avoided big tax hikes so far to pay for these spending plans, something has to give. So there are clearly big incentives to keep government refinancing costs down, most likely pressured by MOF the most. Indeed, Kishida has looked keen for BOJ to maintain its dovish tone as suggested by his initial pick for a new BOJ governor, Amamiya-san who was a co-architect of Kuronimics and sensibly refused the job.

Come what may, however, we think ultimately market forces will dictate the central bank’s move towards policy normalisation. These look likely to come through in either renewed depreciation pressure on the yen or resurgence of bond yields back to test BOJ’s ceilings, or indeed both as we had seen at the latter stage of last year.